Nature-related financial disclosures: the new frontier for ESG risks has been saved
Nature-related financial disclosures: the new frontier for ESG risks
At a glance
- Nature-related risk – encompassing biodiversity loss and ecosystem degradation, and climate-related risk are interdependent but distinct. Both are essential components for the assessment of environmental risk.
- The international Taskforce on Nature-related Financial Disclosures (TNFD) will develop recommendations for organisations to disclose information about their exposures to nature-related risk. This is one example of a broader and accelerating trend for policymakers and regulators to increase the attention being paid to nature-related risk.
- The TNFD’s approach will focus on moving from nature-negative activities to nature-positive activities. The planned disclosures will consider both risks and opportunities for and from nature.
- Financial services firms will need to take steps to embed these risk considerations into their strategies, operations and risk management processes. Even before details of the new disclosures are known, there are actions firms can take now alongside or as part of their work on climate risk that would give them a head start on nature-related risk measurement and management.
The Taskforce on Nature-related Financial Disclosures (TNFD) was launched on 4 June and has been given international political support through endorsement by G7 Finance Ministers. Emulating existing recommendations on climate-related risk disclosures from the TCFD, the TNFD will recommend new disclosures for financial services firms and corporates (organisations) that capture nature-related risks, from 2023.
Biodiversity loss and ecosystem degradation: risks and opportunities to and from nature to organisations
Biological diversity – biodiversity – is the variety of life on earth. Nature-related risk encompasses biodiversity loss and ecosystem degradation. Research has concluded that the health of ecosystems is deteriorating more rapidly than ever. The World Economic Forum (WEF) 2021 Global Risk Report identifies biodiversity loss, and ecosystem collapse and human-made environmental damage, as top risks. Biodiversity loss is highlighted as an existential global threat.
Economic activity can have a negative effect on biodiversity and ecosystems. For example, demand for meat can provide an incentive for deforestation, and the use of chemicals in the production of fruit and vegetables harms the soil. In turn, biodiversity loss and ecosystem degradation pose economic risks. For example, biodiversity loss can negatively affect sectors through an increase in the risk of severe droughts, the disappearance of pollinators, or the collapse of fishing or agricultural yields. The agriculture, food and drink, and construction sectors are particularly exposed to these trends. Other sectors depend on nature through their supply chain.
The response to tackling nature-related risks can also have economic consequences for firms. For example, legislation to limit use of insecticides could lead to higher operating costs for some businesses. Initiatives to reverse biodiversity loss and reduce the risk of severe flooding could lower underwriting costs.
The TNFD’s framework will capture both the risks and opportunities from nature to/for the activities of organisations, and the risks and opportunities from organisations to/for nature.
New disclosure requirements from 2023
The goal of the TNFD is to provide a framework for organisations to report on risks from biodiversity loss and ecosystem degradation. In turn, improving the availability of data and information will enable organisations to integrate nature-related risks more accurately and reliably into decision making.
The TNFD plans to test and refine its framework in 2022, and to launch it in 2023. Its approach will complement and be aligned to that of the TCFD. In particular, the TNFD framework will be structured around the same four pillars: governance, strategy, risk management, and metrics and targets.
A complicating factor for developing disclosures on nature-related risks is that there is no equivalent to simple metrics such as global temperature or greenhouse gas emissions that have helped galvanise efforts to tackle climate-related risk. Moreover, nature-related risk entails a more complex array of factors and is more localised, and mitigating activities are less geographically fungible. Given this complexity the TNFD’s approach will focus on moving from nature-negative activities to nature-positive activities. The planned disclosures will therefore consider both risks and opportunities from nature, across physical, transition and systemic factors.
The TNFD will broadly align itself with the goals of no net-loss of biodiversity by 2030; and net gains by 2050, which are expected to be set in the Post-2020 Global Biodiversity Framework adopted by the UN Convention on Biological Diversity at COP-15 in October this year.
Disclosures will capture information that informs the assessment of stocks of natural capital; flows of ecosystem services; and the value of nature to society and business. It will be important to understand the transmission channel from nature to the economy to the financial system; and to be able to apportion upstream assessments of nature loss at the corporate/industry level.
The TNFD plans to set out a staged approach, with each stage increasing in sophistication, to enable organisations to align themselves progressively with the framework.
Other regulatory initiatives for financial services firms
Biodiversity is already a live topic on the agenda of policymakers and regulators, aside from the work of the TNFD.
As noted above, at the international level the UN Convention on Biological Diversity – an international, legally binding treaty covering biodiversity – will hold its fifteenth COP meeting later this year. Governments are expected there to agree on a new global biodiversity framework that will provide the basis for action to protect nature and reverse nature loss over the next decade. The EU, for example, has also published a 2030 Biodiversity Strategy, and nature restoration will be a central element of the EU’s plan for economic recovery from COVID-19.
Work to determine what regulatory requirements will be set for financial services firms specifically is more nascent, but also already underway.
The UK government-sponsored Dasgupta Review and work by the OECD on the economics of biodiversity are developing approaches to value natural capital – the stock of natural resources, in order that policies can be developed to ensure that the economic costs or opportunities of nature loss/restoration are realised by organisations.
Supervisory authorities are also looking at the topic of nature-related risk. The EBA and ECB in guidelines and requirements on ESG risk have flagged the importance of considering environmental factors in the round, but have noted in their publications to date that the understanding of aspects of environmental factors beyond climate-related risk needs to be developed. And the NGFS will soon publish an outline of a research proposal on the financial stability risks of biodiversity loss.
What should financial services firms do now about this?
Given how much work firms have to do on climate-related risks to very short deadlines and given the lack of information available on nature-related risk issues, is now the right time for firms to devote resources to this – as opposed to simply monitoring developments?
Even before details of the new disclosures are known, there are actions firms can take now alongside or as part of their work on climate risk that would give them a head start on nature-related risk measurement and management. For example:
- It will be necessary to capture more data from customers. Firms should start to think about how they are going to do this without negatively impacting the customer experience, and start building the infrastructure to support it.
- It will be necessary to store these new data and have controls over data quality, etc. Firms should start to think about their operating model and data model to support this.
More broadly, the complexity of the topic means that it warrants early attention by firms. Market or societal sentiment could also shift even more rapidly than regulatory timelines, which firms should be prepared for. As a first step, Boards need to understand how nature-related risk will affect their firm’s business and operations – the financial and strategic risks and opportunities that nature-related risks present.
The scientific community is telling us that potential emergence of new pandemics and climate change have a common cause: the massive and unprecedented degradation of natural habitats by human activities. - Sylvie Goulard, Deputy Governor, Banque de France
This analysis was initially published by Deloitte’s EMEA Centre for Regulatory Strategy.